UPDATE 1-Conflict minerals crackdown backfiring in Congo -UN

* Congo minerals used widely in cell phones, computers (Adds quote on improvements in Katanga, final two paragraphs)

By Jonny Hogg and Graham Holliday

KINSHASA, Dec 30 (Reuters) - A U.S. crackdown on so-called "conflict minerals" in eastern Democratic Republic of Congo has backfired by pushing trade deeper into the hands of criminals, including at least one former rebel leader, a U.N. report said on Friday.

The finding underscores the difficulty faced by both the United States and Congo governments in choking off funding to eastern Congo's roving armed bands, believed responsible for thousands of rapes and killings of villagers.

In an effort to pressure Congo's rebels, the United States adopted a law last year requiring the Securities and Exchange Commission to write rules forcing companies to prove minerals they derived from Congo are "conflict free".

But the rules have not been finalised due to wide opposition from companies and industry groups, creating uncertainty that has led international trading firms to virtually stop all purchases from Congo.

"(This) has mainly led to a loss of production and increased criminality, which I think everyone would agree is not a great result," Gregory Salter, who worked as a consultant for the U.N. report, told Reuters.

Eight years after the official end of a war that killed more than 5 million people, Congo has struggled to tackle rebel groups and criminal elements within its own armed forces that haunt the densely forested east and enrich themselves on illegal mining.

Congo has some of the world's largest deposits of minerals including tin and coltan used in making cell phones and computers, but decades of conflict and corruption mean most of the population remains mired in poverty, a situation made worse by "conflict mineral" crackdown, the U.N. Group of Experts' report noted.

RWANDA SMUGGLING

"This refusal (by international companies) to purchase untagged material left many exporters ... bereft of their main, or only customers, and therefore incomes," the group stated.

Congo exports dropped by around 90 percent following the decision by firms not to accept minerals from the region, mining officials told Reuters earlier this year

"(It) appears to have increased the need for fraudulent operators to seek or accept military assistance in their mineral smuggling operations," the report said.

A former rebel, who is now a general in the Congolese army, is implicated in illegal mineral trafficking, the group said.

Bosco Ntaganda, who is subject to an ICC arrest warrant for war crimes, controls the supply of minerals from the Congolese city of Goma into neighbouring Rwanda, which has seen a rise in smuggling in 2011, the report said.

"The level of recorded domestic production of tin, tungsten and tantalum ores (in Rwanda) continues to be higher than industry analysts consider the real level of production to be... suggesting that material from the DRC is being smuggled into Rwanda, and then tagged as of Rwandan origin," the report said.

Mineral exports from Rwanda are expected to reach $150 million by the end of 2011, up from $118 million in the last financial year between July 2010 and July 2011.

Last month Rwanda returned more than 80 tonnes of minerals to Congo and Rwandan officials have told Reuters that the tagging system, which allows minerals to be traced back to their mine of origin, is working at "nearly 100 percent".

Congo's armed forces have faced repeated allegations of operating illegal mining rackets, and last year President Joseph Kabila suspended mining in the region for six months in an effort to demilitarise the industry.

Congolese Minister of Mines Martin Kabwelulu has dismissed accusations that the Congolese army were involved in illegal mining as "rumours" but said he backed the U.S. legislation to clean up the mining sector.

"For me the Dodd-Frank law is very good, because it stops the criminals from working," he told Reuters by text message.

Salter said improvements had been seen in some areas of Congo, notably northern Katanga, but that when the SEC rules are eventually announced they must allow legitimate trade from the eastern provinces, despite heavy militarisation of the region and instability there.

"There's been a lot of progress made but the missing piece in the puzzle is establishing legitimate supply routes," he said. (Writing by Richard Valdmanis)